Thursday, August 23, 2007

Is Free Trade Working?

Some food for thought for us supporters of free trade.

Today's protectionist drift is similar to the challenges faced by the architect of the original New Deal. In August 1934, President Franklin Roosevelt declared;

'This Government intends no injury to honest business. The processes we follow in seeking social justice do not, in adding to general prosperity, take from one and give to another. In this modern world, the spreading out of opportunity ought not to consist of robbing Peter to pay Paul. In other words, we are concerned with more than mere subtraction and addition. We are concerned with multiplication also -- multiplication of wealth through cooperative action, wealth in which all can share.'

An interesting article in Foreign Affairs magazine by Kenneth F. Scheve, Professor of Political Science at Yale University and Matthew J. Slaughter, Professor of Economics at the Tuck School of Business at Dartmouth, accuses globalisation of failing to spread the wealth and recommends higher taxes for the rich to avert a protectionist backlash.


'Globalization has brought huge overall benefits, but earnings for most U.S. workers -- even those with college degrees -- have been falling recently; inequality is greater now than at any other time in the last 70 years. Whatever the cause, the result has been a surge in protectionism. To save globalization, policymakers must spread its gains more widely. The best way to do that is by redistributing income.'

The authors argue that US policy is turning more protectionist because the US public is turning more protectionist, and the reason is stagnant incomes for all groups except the very richest. The 109th Congress introduced 27 pieces of anti-China legislation, the Doha Trade round is in tatters and other developed nations, particularly France, are upping the anti-foreigner rhetoric.

They then argue that this is a deeply worrying trend as globalisation has been so economically beneficial for both the US (adding $1 trillion to its economy and doubling its worker productivity) and for the developing world, creating an entire new middle class in less than a generation in places such as India and China.

They cite the three commonly expressed opinions as to why globalisation is faltering;

i) the successful lobbying efforts of a few industries that have been hit the hardest (e.g. farmers and manufacturers)

ii) policy makers and the business community have failed to make the case for free trade effectively.

iii) the need to balance economic interests with national security concerns has resulted in a more protectionist stance.

But they go on to dismiss all three arguments and lay the blame squarely at stagnating incomes and the uneven distribution of incomes. They point to data showing an 11% rise in real median wages versus a 58% rise for those in the 90th percentile of income and 121% for those in the 99th percentile. Another way of looking at this data is the CEO/worker ratio which has jumped from 80x in the 1980s to 425x in 2005 (see graph above). the last time data such as this appeared was in 1928 - just before the Great Depression (caused ironically by a rise in protectionism).

A combination of globalised free trade and high immigration is exerting immense pressure on wages of the low-skilled and they know it. Hence politicians (all the Democrat nominees for the Presidency are espousing some protectionist policies) are merely responding to growing resentment amongst the population.

The authors argue that supporters of free trade now face a stark choice; ensure workers share more of the spoils or accept that liberalisation is no longer sustainable. Given how important free trade is for the US economy, they argue that tax breaks must be distributed to the poorest workers to be paid for by the richest. Their solution is to eliminate payroll tax (15%) for those workers earning below the median wage and to increase them for the richest.

Update; Jason Soon points me to this very interesting paper. The authors point out that whilst income inequality is indeed rising, inequality by race and sex are rapidly diminishing, especially for American black and Latino women.